At Estately Wealth, we blend sophisticated financial planning with personalized strategies to help our clients preserve wealth, optimize corporate structures, and make impactful charitable contributions. At Estately Wealth, we blend sophisticated financial planning with personalized strategies to help our clients preserve wealth, optimize corporate structures, and make impactful charitable contributions. At Estately Wealth, we blend sophisticated financial planning with personalized strategies to help our clients preserve wealth, optimize corporate structures, and make impactful charitable contributions.
Borrowing Against Life Insurance Policies: Corporate vs. Private Borrowing
Life insurance policies with cash value provide a versatile financial tool that can be used as collateral for loans. This strategy can be advantageous for both corporations and individual shareholders, but the implications and benefits vary significantly between these two approaches. In this blog post, we’ll explore corporate and private borrowing against life insurance policies, including case studies and a detailed look at guarantee fees.
Understanding the Basics
Collateral Loans Using Life Insurance Policies:
- Corporate Borrowing: The corporation owns a life insurance policy, uses it as collateral, and receives the loan proceeds.
- Shareholder Borrowing: The corporation owns the policy, but the loan proceeds go directly to the shareholder.
Corporate Borrowing
Mechanism:
- A corporation owns a life insurance policy with cash value.
- The policy is assigned to a bank as collateral for a loan.
- The corporation receives the loan proceeds tax-free.
- The corporation can pay dividends to shareholders using the loan proceeds.
Tax Considerations:
- Interest on the loan may not be deductible unless it meets specific criteria.
- On the death of the insured, the death benefit is used to repay the loan, and the remaining amount is paid to the corporation.
- The corporation gets a capital dividend account (CDA) credit for the full death benefit, which can be paid out as tax-free capital dividends to Canadian resident shareholders.
- The loan reduces the value of the corporation’s shares for tax purposes, potentially lowering capital gains tax at death.
Case Study: Corporate Borrowing
Scenario: Michelle, a 50-year-old doctor, runs a successful medical practice through a professional corporation. She plans to retire in 20 years and wants to leverage her corporation’s excess earnings to secure her retirement.
Details:
- Michelle’s corporation owns a life insurance policy with a cash value.
- The policy is assigned to a bank as collateral, and the corporation receives a loan.
- The corporation uses the loan proceeds to invest and grow its assets.
- Upon Michelle’s retirement, the corporation pays dividends to Michelle, providing her with a steady income.
Outcome:
- The corporation enjoys tax-deferred growth within the policy.
- The CDA credit allows for tax-free dividends to Michelle.
- The loan reduces the share value for capital gains tax purposes, benefiting Michelle’s estate planning.
Shareholder Borrowing
Mechanism:
- A corporation owns a life insurance policy with cash value.
- The policy is assigned to a bank as collateral for a loan.
- The loan proceeds go directly to the shareholder tax-free, but the corporation’s assets secure the loan.
Tax Considerations:
- The shareholder must pay a guarantee fee to the corporation to avoid a taxable shareholder benefit.
- Interest on the loan is generally not deductible if used for personal purposes.
- On the death of the insured, the repayment of the loan must be carefully managed to avoid creating a taxable shareholder benefit.
Case Study: Shareholder Borrowing
Scenario: John, a 55-year-old business owner, wants to access funds from his corporation’s life insurance policy to enhance his lifestyle without triggering immediate taxes.
Details:
- John’s corporation owns a life insurance policy with a substantial cash value.
- The policy is assigned to a bank, and the bank extends a loan directly to John.
- John uses the loan proceeds for personal expenses and investments.
Outcome:
- John receives the loan proceeds tax-free.
- He pays a guarantee fee to the corporation, which mitigates the risk of a taxable shareholder benefit.
- Upon John’s death, careful planning ensures the loan repayment is managed to avoid significant tax consequences.
Understanding Guarantee Fees
What is a Guarantee Fee?
- A guarantee fee is a payment made by the shareholder to the corporation for using the corporation’s assets (in this case, the life insurance policy) as collateral for a loan.
- This fee is intended to avoid a taxable shareholder benefit.
Rates:
- Guarantee fees typically range from 0.5% to 4%.
- The fee can be influenced by the rate for a letter of credit or determined through a professional valuation.
Impact Example:
- If a 2% guarantee fee is applied over 21 years, the cumulative fee paid by the shareholder can amount to $807,000.
Conclusion
Borrowing against life insurance policies can be a powerful financial strategy, whether done at the corporate level or directly by shareholders. Corporate borrowing often provides more favorable tax treatment and flexibility, while shareholder borrowing offers immediate access to funds. Understanding the intricacies, including the role of guarantee fees, is essential for making an informed decision that aligns with long-term financial goals.
For more personalized advice and to explore how these strategies can work for you, contact Estately Wealth Planning today. Our experts are here to guide you through every step of leveraging life insurance policies for financial growth and stability.
Ready to secure your future and protect your loved ones? Book a time to sit down with us and start your estate planning journey today! Visit our calendar to schedule your consultation. We look forward to helping you achieve peace of mind.
